My question is: how will any withdrawals be allocated to taxable and untaxable amounts.
Let’s start with the right terminology. That will help in understanding what has happened and what will happen.
the capital gains statement
What you have is not a capital gains statement. It is a 1099-DIV. It reports the dividends paid to you (or DW) from owning shares of stock in a mutual fund. Mutual funds are slightly funny corporations. If you own shares of stock in something like AT&T, you will get dividends. But before AT&T pays those dividends, they have to pay their income taxes on their earnings. Then they pay some of the remaining earnings out to shareholders as a dividend. Then the shareholders pay taxes on those dividends.
But a mutual fund gets a special tax break. As long as a mutual fund pays out the vast majority of their earnings as dividends, the fund itself (remember, it’s a corporation) doesn’t have to pay income tax on it’s earnings. A second benefit is that the dividends paid to shareholders (that’s you and DW) get to retain their character. So a mutual fund that collects qualified dividends from the companies it invests in gets to pass those qualified dividends to shareholders. Or a mutual fund that collected municipal bond interest gets to pass that non-taxable interest through to its shareholders. And the same thing happens with capital gains. When the mutual fund has a long-term capital gain from selling its investments, those gains get passed through to shareholders. Short term capital gains get a slightly short shrift, as they become non-qualified dividends. Still taxed at the same rate, but loses its nature as a capital gain. That could be important to a shareholder with capital losses - they can’t use the fund’s short term gains against their personal losses in the way they can with the fund’s long-term capital gains.
You’ll note above that I said the mutual fund pays you dividends. And you may be asking where are those dividends. After all, it appears that you never got a check (or a direct deposit, or anything similar). Well, you could have received the money. But it’s likely that DW elected to have those dividends reinvested way back when. So when the fund pays a dividend, they use the dividend to buy more shares of the fund. For tax purposes, this is treated as two separate transactions. First, the fund pays a dividend, which you get taxed on. Then the dividend is used to buy more shares of the fund.
how will any withdrawals
There are no withdrawals from a mutual fund. You own shares of stock. Shares of stock must be sold to convert them into cash. So just like any other stock sale, you calculate your gain or loss on the sale by taking the sale proceeds and subtracting your cost of those shares. The difference is your gain or loss.
But what is the cost (often called basis or cost basis) of the shares? Another excellent question. And one where you may not like the answer. Your cost is determined by each separate purchase, including the purchases from reinvesting dividends. Since it appears that the fund was first purchased sometime before the year 2000, you will have a data gathering exercise on your hands. Assuming some occasional investments and quarterly dividends and 20+ years of ownership, you may have 100 or more separate purchases to deal with. ***(See note)
So you don’t really allocate a “withdrawal” between “income” and “market fluctuations”. Those phrases have no meaning in a tax context. You have to calculate your cost basis of the shares sold and compare that to the sale proceeds to calculate a gain or loss.
That’s all well and good if you sell all of your shares at once. But what if you just sell some of the shares? Are those the shares from the original investment back in the 20th century? Are they from a dividend reinvestment in 2009? Or are they the shares from the most recent dividend? The answer can be “yes”. They could be from any of them. But they don’t have to be.
You have three options to determine which shares you sold. You can sell the shares on a First In, First Out (FIFO) basis. That is, the oldest shares are sold first.
Or you can specifically identify which shares you are selling. So you can sell 10 shares, with 3 of those shares coming from the original purchase way back when, 6 of the shares from the April 2013 dividend, and one more share from the most recent dividend. So you dutifully look up the basis of those specific shares and use that to calculate your gain or loss AND whether that gain or loss is short term or long term. In my slightly wacky example, that 1 share is probably short term, while the others are definitely long term.
This option has a couple of hoops to jump through, mainly identifying the shares before the sale happens and getting your broker or the mutual fund company to acknowledge your identification of the shares you sold. The process for doing this will vary from fund to fund and broker to broker. So you’ll need to find out how it works in your specific situation.
Lastly, you can use an average cost basis. This is only available to mutual funds, not to stock in common companies. So make sure to read carefully when you find things that say you can’t use an average cost. They are almost certainly talking about ordinary companies and not mutual funds. The process for figuring that average cost is pretty straight forward. Take the dollar total of all of your purchases (again, keeping in mind that a dividend reinvestment is just another purchase) and divide by the number of shares owned. That gives you your average cost per share.
–Peter
***(Note) You will likely get some assistance from TRP with this. Since around 2008 - 2010 or so, brokers and mutual funds have been required to keep track of your basis for you. And many did so long before they were required to. So it’s possible, but not a guarantee by any means, that TRP can tell you what your basis is. And it’s possible they could provide you the information on all of your purchases and reinvestments so you can calculate your basis. Either way, you’ll only need to deal with the older information. The basis for the last decade plus a couple of years is already being tracked for you.